The stock in this example (JDS Uniphase Corp.) actually did have average annual returns of 37 percent over the period January 1, 1997, through December 31, 2002. But the growth rate (which takes into account the impact of the volatility) was an anemic -3.6 percent per year. The average return was pretty good, but the volatility of the stock's performance killed the growth rate.

The stock had extraordinary performance in the period leading up to early 2000, but this was matched by equally poor performance in 2001 and 2002. The result was that average returns were strongly positive for the six year period, but the overall cumulative performance was poor. This is an extreme example, but clearly demonstrates the danger of focusing too much attention on average returns without considering the impact of volatility. Remember that volatility matters a lot in accumulating wealth over time.

The above is an excerpt from the book The Intelligent Portfolio by Christopher L. Jones Published by John Wiley & Sons, Inc.; May 2008;$27.95US/$30.99CAN; 978-0-470-22804-3 Copyright © 2008 Christopher L. Jones

Author Bio Christopher L. Jones is Chief Investment Officer and Executive Vice President of Investment Management for Financial Engines. Working closely with founder William F. Sharpe, Jones built and led the team of experts in finance, economics, and mathematics that developed the financial methodology for Financial Engines' personalized investment advice and management services. Jones has led the investment management function at Financial Engines for more than a decade. He holds an MS in business technology, an MS in engineering-economic systems, and a BA in quantitative economics, all from Stanford University.

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